How To Find Companies With Strong Competitive Moats

Apr. 12, 2017 1:46 AM ET1 Comment
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In medieval times, castles that were best protected from sieges were those with the widest, deepest moats. On the investment battlefields of the stock market, moats are a figurative pointer to some of the strongest, most durable companies. But how do you find them?

The ‘economic moat’ is a metaphor first used by the billionaire investor Warren Buffett to describe the type of business he likes to buy. These days it’s often used as a measure of durable competitive advantage.

The idea is that a select few companies not only churn out persistently strong returns, but they have extra advantages that make it difficult for rivals to copy them. As a result, their investors can benefit from superior returns that are compounded over the long term.

What makes a moat?

One of Buffett’s examples is the American auto insurance giant Geico, which is owned by his Berkshire Hathaway (BRK.A) (BRK.B) group. In recent years he’s regularly noted: “The company’s low costs create a moat – an enduring one – that competitors are unable to cross.”

In Geico’s case, the moat is the sheer scale of the business that allows it to dominate the market by operating at low cost. But moats aren’t always about size, scale and cost. They can be market leading brands or products that consumers are reluctant to stop using. Classic examples are big drinks manufacturers like Coca-Cola (KO) and Diageo (DEO) and FMCG companies like Reckitt Benckiser (OTCPK:RBGLY).

Sometimes they’re businesses with large distribution infrastructure that would be difficult and expensive to replicate. Others have products and services with ‘networking effects,’ which encourage customers to feel part of an exclusive club. Or they may have brands that customers closely identify with. Examples here range from Facebook (FB) to Harley-Davidson (HOG) to Apple (AAPL).

In his book,

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